CHAPTER 3 Flashcards
What are the common-size statements?
A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statement items as a percentage of sales.
What are the financial ratios?
Relationships determined from a firm’s financial information and used for comparison purposes.
What are short term solvency or liquidity measures?
It provides information about a firm’s liquidity. The primary concern is the firm’s ability to pay its bills over the short run without undue stress. These ratios focus on current assets and current liabilities. One advantage of looking current assets and liabilities is that their book/market values are likely to be similar. One disadvantage is that near cash, current assets and liabilities can and do change fairly rapidly. Includes Current Ratio, Quick ratio, Cash ratio.
What is the Current Ratio?
Current Ratio = Current Assets/ Current Liabilities
The current ratio is a measure of short term liquidity. Measures how much current assets can cover current liabilities.
To a creditor, higher Current ratio the better.
To the firm, a high current ratio indicates liquidity but it also may indicates an inefficient use of cash and short term assets. We would expect at least 1 current ratio.
What is the Quick or acid test ratio?
Quick Ratio = (Current Assets - Inventory)/ Current Liabilities
Inventory is often the least liquid current asset. Large inventories are often a sign of short-term trouble. Low quick ratios mean large inventories make up the Assets.
What is the Cash Ratio?
Cash Ratio = Cash/ Current Liabilities
A very short term creditor might be interested in the cash ratio
What are Long-Term Solvency Measures?
Long-term solvency ratios are intended to address the firm’s long run ability to meet its obligations or its financial leverage. These ratios are called financial leverage ratios or leverage ratios.
What is Total Debt Ratio? What are the three ratios?
Takes into all debts of maturities to all creditors.
Total Debt Ratio = (Total assets - Total Equity)/ Total Assets
Debt-Equity Ratio = Total Debt/Total Equity
Equity Multiplier= Total Assets/ Total equity
What is Times Interest Earned ratio?
(TIE)Its another common measure of long term solvency. This ratio measures how well a company has its interest obligations covered and it is often called the interest coverage ratio. The problem with the TIE ratio is that is it based on EBIT which is not really a measure of cash available to pay interest. EBIT = Earnings before Interest and Taxes
TIE = EBIT/ Interest
What is Cash coverage?
Cash Coverage ratio = (EBIT + Depreciation)/ Interest
It is a basic measure of the firms ability to generate cash from operations and it is frequently used as a measure of cash flow available to meet financial obligations.
What are asset utilization ratios?
We discuss all can be interpreted as measures of turnover. What they are intended to describe is how efficiently or intensively a firm uses its assets to generate sales.
What is Inventory turnover?
Inventory Turnover = Cost of Goods Sole/ Inventory
In a sense we sold off or turned over, the entire inventory x times. As long as we are not running out of stock and thereby forgoing sales, the higher this ratio is, the more efficiently we are managing inventory.
What are the Day’s Sales in inventory?
Days’ sales in inventory = 365 days/ Inventory turnover
This tells us that, roughtly speaking, inventory sits about x days on average before it is sold.
What is receivables turn over?
We now look at how fast we college on those sales.
Receivables turnover = Sales/ Accounts Receivable
The results tells us that we collected our outstanding credit accounts and reloaned the money x times during the year.
Days’ sales in t receivables?
Days’ sales in receivables = 365 days/ Receivables turnover
This tells on average we college on our credit sales in about x days.
What is Total Asset Turnover?
Total Asset Turnover = Sales / Total Assets
This tells us that for every dollar in assets, we generated x in sales.
What is Capital Intensity ratio?
It is the reciprocal of the total asset turnover. This can be interpreted as the dollar investment in assets needed to generate $1 in sales. High values correspond to capital intensive industries (public utilities)
What are the Profitability Measures?
They are intended to measure how efficiently the firm uses its assets and how efficiently the firm manages its operations.
What is the Profit Margin?
Profit Margin = Net Income/ Sales
This tells us that this generates about X cents in profit for every dollar in sales. A relatively high profit margin in obviously desirable.
What is Return on Assets?
Return on Assets = Net Income/ Total Assets
What is Return on Equity?
Measures of how stockholders fared during the year. The true bottom line measure of performance.
ROE = Net Income/ Total Equity
Price Earnings Ratio?
PE Ratio = Price per Share / Earnings per Share
PE ratio measures how much investors are willing to pay per dollar of current earnings, higher PEs are often taken to mean that the firm has significant prospects for future growth. If a firm had no or almost no earnings, its PE would probably be quite large so as always care is needed in interpreting this ratio.
Price - Sales Ratio?
Price-Sales Ratio = Price per share/ Sales per share
As with PE ratios, where a particular price-sales ratio is high or low depends on the industry involved.
Market to Book Ratio?
Market to Book Ratio = Market Value per Share/ Book Value per share
The market-to-book ratio compares the market value of the firm’s investments to their costs. A value less than 1 could mean that the firm has not been successful overall in creating value for its stockholders.
What is DuPont Identity?
Popular expression breaking ROE into three parts: operating Efficiency, asset use efficiency, and financial leverage.
ROE = (Net Income/Sales)(Sales/Assets)(Assets/Total Equity)
